Many Mexicans believe that their country has gone through a period of
“neoliberal” free-market reform and that it hasn’t worked. This
misconception deprives them of an economic alternative and vision for
the future.

In fact, neoliberal reforms and free trade in Mexico were frequently
fake. The so-called neoliberalism was crony capitalism dressed up using
the language of free markets. Managed trade with many exceptions and red
tape has often been touted as wild capitalism. In Mexico, elite control
of the economy through government was simply replaced by elite control
through crony capitalism—the handing off of state assets, monopolies,
and protection from foreign competition and other rent-seeking
opportunities to friends, supporters, and relatives of the regime.
Rather than releasing entrepreneurial drive, it protected privilege. Yet
governments in Latin America and international institutions like the
International Monetary Fund and the World Bank praised Mexico for its
“free-market” reforms.

Even though Mexico divested itself of state enterprises and opened up
the market through privatization, this has often been illusory. The old
elites simply took the “privatized” assets and continued their control
of the economy under crony capitalism. This is the very opposite of free
markets, with the rich and the powerful suppressing the freedom and
opportunity of others. The so-called neoliberal reforms did not touch
special interests. They ignored problems such as crony capitalism, a
heavy regulatory burden, subsidies, corruption, and unequal distribution
of the gains of growth, both socially and geographically. This is why
there has been an aversion to free markets in Mexico. People think that
Mexico experienced free markets, and inequality subsequently increased,
when in reality, the Mexican people have not really experienced free
markets and free trade.

In the 1980s, the Mexican economy was dominated by state-owned
enterprises: telephone companies, banks, bus companies, railways,
fertilizers, even a yogurt company. Given the fact that most of the
companies were in the red, the government resorted to printing money, or
getting the country into debt. Many companies were privatized in the
late 1980s, except for the oil and electricity sectors for ideological
reasons. If this privatization had not taken place, Mexico could well
have entered into a period of hyperinflation.

Many of the privatizations were not sold to the highest bidder, though,
but were instead handed to government cronies. Loyalty to the people in
power was rewarded. The most famous case is the telephone company Telmex,
which was sold on credit. Even after privatization, the company enjoyed
a monopoly market. After 1994, under the North American Free Trade
Agreement, foreign companies were allowed in. AT&T and MCI came to
Mexico, but they had to partner with local companies because they could
not hold more than 49 percent of a Mexican subsidiary. So, for many
years, AT&T had to connect with Telmex and pay Telmex a connection fee,
and it could only offer long distance calls, not local calls. In this
way, AT&T was handcuffed, with limited ways to invest more in the
Mexican market. Thus the opening to foreign direct investment (FDI) was
cosmetic, and a former public monopoly became a protected private
monopoly. The Mexican people suffered with higher prices for telephone
services, so Telmex got extra rents from the Mexican people, with an
increase in inequality. Yet there is hope. In 2013, a reform was enacted
that seems very promising and has opened the telecommunications sector
to more FDI. Already, Virgin Mobile has arrived in Mexico, and AT&T is
planning more investment.

From the 1940s until the 1980s, Mexico followed the model of import
substitution industrialization: It created tariff and non-tariff
barriers, and used import permits, to shield local producers from
foreign competition. The results were predictably disappointing. It
forced mature foreign companies to produce in Mexico, usually at a
higher price than abroad. It created infant industries that never
matured. There was no innovation, no care for quality. It created the
most horrendous inequality, with the local market being too small for
companies to have economies of scale, and thus it did not create a lot
of employment. Poverty belts surrounded every city in Mexico. Import
substitution industrialization started generating macroeconomic
disequilibrium, and created the conditions for the 1982 crisis.

Given the severity of this crisis, Mexico had to start opening up its
economy. In 1986, Mexico entered into the GATT, and in 1994, the North
American Free Trade Agreement. These two actions started opening Mexico
up to foreign trade. Exports started increasing to unprecedented levels,
and the maquiladora industry gained momentum. Mexico also signed other
trade agreements with Europe, Israel, Japan, and some South American
countries. But even though Mexico has signed various trade agreements
since 1994, these have been gradual, and have left many exceptions in
place in order to protect certain groups from foreign completion.
Tariffs from countries outside of the trade agreements have been very
high. For instance, tariffs applied to some Chinese goods can reach 500
percent. There is a high level of variability in the tariff rates. The
customs system is complex and constantly changing. This is the result of
protecting groups from foreign competition, thus increasing inequality.
It weakens the rule of law, and increases the level of unpredictability.

The poster child for protectionism in Mexico is the automobile industry.
The first auto assembly plant in Mexico was established in 1925 by Ford.
By 1940, there were several international auto companies. But 1940 is
when import substitution industrialization got started in order to force
foreign companies to assemble cars locally under the presidency of
Miguel Aleman. In the 1960s, import substitution was deepened, forcing
auto manufacturers to have 60 percent Mexican content. This regulation
had unintended consequences: Volvo, Mercedes, and others simply
abandoned the country. They could not produce 60 percent of content
locally given that the market was too small for economies of scale.
During the period of import substitution, cars assembled in Mexico were
lagging behind by about 8 years, quality was low, there was not much
variety, and Mexico never exported, except in 1982 when a Volkswagen
dealer sold Fidel Castro 12 Westphalia vans. Cars made in Mexico were
sold at more than double the price of cars made in the USA. Since Mexico
entered the NAFTA agreement, the car market has been slowly liberalized.
Indeed, it has experienced dynamic changes, becoming an exporter of
cars. In fact, Mexico is the 4th largest exporter of cars in
the world, as well as the largest exporter of trucks and auto parts.
That is the miracle of liberalization, something never accomplished
during the import substitution industrialization period.

With the NAFTA agreement started a period a gradual liberalization,
first with the new cars, and then with some used cars. The final
liberalization for used cars will take place in 2019. The fact that the
liberalization for used cars has been very gradual has created its own
unintended consequences. Used cars in Mexico are still more expensive
than used cars in the US. AMDA (the Mexican cars distributors
association) has lobbied to create non-tariff barriers in order to make
US cars more expensive in the Mexican market. They don’t want prices of
used vehicles to go down. This lack of liberalization of the used car
market in Mexico has impacted low income households, thus increasing
inequality. People thought that with free trade, they would be able to
go to the US and buy a car, and import it into Mexico easily, but this
has not been the case, thus creating a lot of disenchantment with “free
trade.” The protection given to the distributors’ network has also
impacted tourism negatively. American tourists need to get a permit to
bring a car beyond the border cities, thus opening the door to arbitrary
actions from customs officials, a source of corruption. Even though
Mexico has great touristic assets, it has not been living up to its
potential because of the protection given to Mexican car distributors.
Thus, the protectionism of the distribution network transfers resources
from low income families to the car distributors’ network.

“Even though Mexico has
competitive problems and inequality issues, the recent
reforms in electricity and hydrocarbons will have a positive
impact in the economy as a whole.”

Competitiveness

Since Mexico has started abandoning import substitution
industrialization, it has entered into a new dynamic. There are
companies which have focused on the export market (like the maquiladora
industry) that have won prices in quality. The maquiladora industry has
evolved from simple operations to more complex assembly like cars, TVs,
auto parts, computers, and aeronautics.

On the other hand, there are other industries which are not linked to
world markets and which are still asking for protection from foreign
competition.

Mexican agriculture has evolved to become an exporter of agricultural
goods that 20 years ago were not known in Mexican markets. Mexico has
become an exporter of berries, eggplants, cucumbers, leeks, peppers, and
asparagus to the US and the world. Mexico is also a top exporter of
tequila. But there is still a part of agriculture that is not
mechanized, that does not export and that has low productivity levels.

The mining sector is also a mixed bag. There are some states that are
friendly to mining and appreciate the benefits of this sector.
Regulations have been streamlined and have increased investment. Mexico
has attracted substantial mining investment, although still below its
potential. On the other hand, in other states there is distrust and
harassment by radical groups trying to make money with frivolous
accusations and inflammatory declarations against (mostly Canadian)
mining companies.

Opening a business in Mexico has become relatively easier in recent
years, but there is still much room for improvement: administrative
requirements, bureaucracy costs, extra payments, and favoritism are
still a challenge.

Another challenge for Mexico is the respect for contracts and
legitimately acquired property. It can take a lot of time and effort to
get a contract enforced in the court system. Property registration has
not been very efficient, which opens the door to multiple claims on the
same property.

The union system is still a drag on competitiveness as well. There is no
democracy in unions: If the company is unionized, new workers have to
belong to the union. Membership dues are discounted automatically from
paychecks and given to the union. The unions have not actually been
helping Mexican workers, but they have been a source of enrichment for
union leaders.

In the maquila industry, the unions are not so powerful, given the high
turnover rate. In the public sector, though, the unions create
rigidities. In the education system, there is no line between the
Ministry of Education and the teachers union. The unions distribute jobs
in education, thus creating barriers to the best-educated who are not
connected with the union bosses.

The level of English language skills of Mexicans is very deficient even
though the country is close to the US, and the unions have not allowed
competent US teachers to teach in Mexico’s public schools.

The unions in the state-owned oil and electricity companies have been a
source of corruption, nepotism, selling jobs, and exchange of favours.

Energy Security

In 2013, Mexico passed laws that will open the hydrocarbons and
electricity sectors to foreign and local private investment. This is a
revolutionary change. In the 1930s, Lazaro Cardenas expropriated the oil
and gas. The expropriation had serious consequences for the legal
system: Cardenas appointed judges who agreed with his policy, thus
weakening the independent judiciary. Even with the expropriation,
foreign direct investment was not forbidden; foreign companies could
still associate themselves with Pemex, the national oil company.

However, the greatest blow came in the 1960s with the Lopez Mateos
administration. During its term, FDI in the oil sector was completely
forbidden. The expropriation and lack of competition created corruption
at unprecedented levels, and the oil union became so powerful that even
the jobs at Pemex were sold. During the 1990s, as demand for gasoline
increased and new cars required higher quality gasoline, Pemex
associated with Shell to open a refinery in Houston in order to refine
Mexican crude there to satisfy Mexican demand. That was the biggest
irony: Mexico sought energy independence with a nationalist rhetoric,
and in fact it became more dependent on partners abroad. The same thing
with natural gas: Mexico has huge reserves in the north, but it had to
import gas from the US to satisfy demand, with a price 3 or more times
higher than in the US. Oil production has been decreasing in the last
decade: Without new discoveries, Mexico would have been a net importer
of crude oil in a few years.

During his presidency, Felipe Calderon tried to open up the country to
FDI, but he achieved only very moderate change. Congress approved
service contracts with Pemex, but that did not attract a lot of
investment given that during companies could not benefit from the rise
in oil prices when it occurred.

Foreign companies will soon be able to partner with Pemex under
profit-sharing contracts. This will increase exploration in the deep
waters of the Gulf of Mexico and in places in the impoverished south
like Chiapas. In the medium and long run, it will increase production
and reserves.

A great opportunity is the shale gas reserves which are located mostly
in the north of Mexico, in the region from Ciudad Juarez to Ojinaga in
the state of Chihuahua. Other concerned regions are in Coahuila, Nuevo
Leon, Tamaulipas, and Veracruz. It is a great opportunity to transform
marginalized regions into more prosperous ones. It will provide revenue
for farmers in the form of access fees. The cost of energy will decrease
for households and enterprises, and the costs of electricity and of
refining will be impacted.

The only danger is that various groups are disseminating hysterical
information about fracking in an attempt to scare the public. If they
win the media battle, they can create paralysis and a race to the
bottom, and no politician will be willing to defend shale gas. One
group, El Barzon, that in the past used to harass Canadian mining
companies, has now started a virulent campaign against fracking.
Environmental consulting and law firms stand to benefit from creating a
litigious environment in the shale gas industry. Gas companies, and
society in general, have to wake up and realize the economic benefits of
shale gas before the radical groups win the media battle like they did
it in Quebec.

As for the electricity market, in the late 1800s, foreign companies
started building hydropower in Mexico. One of the most important hydro
projects was the Boquilla dam in northern Mexico, built with Canadian
capital. During the time of import substitution industrialization, there
was wave of economic nationalism. Electricity generation companies were
nationalized in 1960s, which ended the tradition of building hydro
power. After the 1960s, the government company started building
thermoelectric plants which used coal and oil as fuel, thus creating
more pollution. During the past 20 years, electricity demand has
exceeded supply, but the government could not build new generations
plants due to budget constraints. There were efforts to open up the
electricity sector to foreign investment, but they were blocked for
ideological reasons. Fortunately, after many years of impasse, the
Mexican Congress approved a reform that opened up the electricity sector
to foreign companies. Now foreign companies will be able to produce
electricity and sell it in bulk to the national electricity company.

Even before the Congress authorized foreign direct investment in
electricity, there was a silent revolution in electricity generation, by
wind energy. There are wind farms in the states of Nuevo Leon,
Tamaulipas, Jalisco, Oaxaca, Chiapas, and Baja California. Some of the
companies present are Iberdrola, Fenosa, and mining companies like
Penoles and Grupo Mexico.

Even though Mexico has competitive problems and inequality issues, the
recent reforms in electricity and hydrocarbons will have a positive
impact in the economy as a whole. It will decrease the price of inputs
for industry, agriculture, and households. It will also send a positive
message that the Mexican economy is going through a profound
transformational period, not a cosmetic one.